Money Funds Seen Failing in Crisis as SEC Bows to Lobby

Mary Schapiro, chairman of the U.S. Securities and Exchange Commission (SEC), at a House Financial Services hearing in Washington. Photographer: Andrew Harrer/Bloomberg

Aug. 1 (Bloomberg) -- Money-market fund companies have
doubled lobbying efforts to convince regulators and lawmakers
that they aren’t a threat to the financial system. The money may
have been well-spent.

The 10 biggest money-fund managers and the Investment
Company Institute trade group reported combined lobbying
spending of $16 million in the first half of 2012 and $31.6
million last year in disclosures that reference money-market
mutual funds, according to a review of documents by Bloomberg
News. That compares with $16.7 million in all of 2010.

The companies are seeking to block new rules championed by
Securities and Exchange Commission Chairman Mary Schapiro that
are headed for a vote before a divided commission as soon as
this month. The proposal would force funds to abandon their
fixed $1 share price or introduce withdrawal limits and capital
buffers. Schapiro can count on only one supporting vote from the
other four commissioners, even as Federal Reserve officials have
said that failure to enact tougher rules will leave the $2.5
trillion industry vulnerable to investor runs and threaten
global credit markets.

“If the industry blocks this plan and something else bad
happens and people on Main Street lose money, they’ll be kicking
themselves for not fixing this,” Douglas W. Diamond, a finance
professor at the University of Chicago Booth School of Business,
said in a telephone interview. “The current structure does
potentially have systemic risk, and it’s the kind of thing that
could happen very quickly given the situation in Europe.”

Lehman Fallout

Money-market mutual funds, which hold short-term debt and
are used by clients for liquidity, are part of the so-called
shadow banking system, along with hedge funds and other
institutions not subject to banking regulation, that provide
cash globally.

The industry has drawn scrutiny since the September 2008
collapse of the $62.5 billion Reserve Primary Fund, which held
debt issued by Lehman Brothers Holdings Inc. Its closure a day
after Lehman’s bankruptcy triggered an industrywide run on funds
eligible to buy corporate debt, helping to freeze global credit
markets.

The run abated only after the U.S. Treasury guaranteed
money fund shareholders against losses on more than $3 trillion
in securities for a year and the Fed began financing the
purchase of fund holdings at face value to help them make
redemptions. Congress has since prohibited the Treasury from
acting in the same way again.

Aguilar’s Meetings

The SEC passed rules changes in 2010 requiring funds to
meet liquidity minimums, reduce average maturities and disclose
holdings more frequently, and allowing funds to close more
quickly in an emergency. Schapiro has said more action is needed
to prevent another run.

Her plan, presented to commissioners June 25, has the
support of Democrat Ellise B. Walter at the SEC, while
Republican commissioners Troy A. Paredes and Daniel M. Gallagher
have said they oppose the plan. Luis A. Aguilar, a political
independent appointed by President Barack Obama, has signaled
his opposition without saying whether he would kill it before
inviting public comment.

Aguilar has held 11 meetings in the past eight months with
fund companies and others opposed to additional regulation,
according to SEC records. Other opponents include the U.S.
Chamber of Commerce and corporate treasurers from CVS Caremark
Corp. and retail food chain Safeway Inc.

Building Opposition

The U.S. Chamber paid for one prominent public display
objecting to the SEC plan in April when it purchased more than
30 advertising spaces in the Union Station Metro stop in
Washington, D.C., where many of the SEC’s employees arrive for
work each morning. The chamber didn’t disclose how much the
effort cost.

Featuring large, colorful question marks, the ads argued
that money-market funds are “strong,” and asked, “why risk
changing them now?” David Hirschmann, a chamber official, said
the effort is part of a campaign to highlight questions that
business wants to ask regulators about the need for additional
rules.

Aguilar, the independent commissioner, is among SEC
employees who ride the Metro to work.

The ICI, in addition to lobbying commissioners and Capitol
Hill, hired public relations firm MWW Group, based in East
Rutherford, New Jersey. MWW was paid $300,000 to $400,000 to
build opposition to the SEC’s plans among corporate treasurers
and state and municipal government officials, according to a
person familiar with the project who wasn’t authorized to speak
publicly.

Liquidity Bank

The ICI spent an undisclosed amount to pay for a survey of
corporate treasurers conducted by consulting firm Treasury
Strategies. The results, released in April, showed a majority of
treasurers would decrease or discontinue their use of money
funds if the SEC enacted the Schapiro plan.

The ICI also led early efforts to propose alternative
reform plans the industry would accept. Its detailed
recommendation that industry participants form a liquidity bank
capable of backstopping funds during a crisis cost $3 million to
$4 million to prepare, the person said. The plan was rejected by
regulators because it would require granting the facility access
to the Fed’s discount window for emergency lending.

Stable Value

Money funds don’t use market prices to value holdings. To
maintain a $1 share price they value securities very close to
their face value and round the fund’s per share net asset value
to the nearest penny. Earnings from the investments are
distributed monthly to shareholders as cash or new shares.

Regulators have argued at least since June 2009 that the
stable share price encourages flight from money funds at the
first sign of trouble, because it allows those who react quickly
to sell their shares at $1 each even if the net asset value has
dropped below that level. The remaining shareholders, usually
less sophisticated, individual investors, are left to shoulder
the losses when the fund is no longer able to redeem at the
stable price.

Schapiro said in June before the Senate Banking Committee
that funds continue to pose a threat to the financial system.
She has received public backing from Eric Rosengren, president
of the Federal Reserve Bank of Boston, and Treasury Secretary
Timothy F. Geithner.

Still ‘Vulnerable’

“I still believe, as does the SEC and the Fed, that they
are still vulnerable to runs that cannot just disadvantage
investors, but could hurt the system as a whole,” Geithner said
July 27 before the same Senate panel.

Geithner added that if the SEC doesn’t take action, the
Financial Stability Oversight Council could. FSOC, established
under the Dodd-Frank law, is charged with identifying, and
acting to contain, systemic risks. Its members include Geithner,
Schapiro, Fed Chairman Ben S. Bernanke and other senior
government officials.

The top fund companies include Boston-based Fidelity
Investments; New York’s JPMorgan Chase & Co.; Federated
Investors Inc. in Pittsburgh; Valley Forge, Pennsylvania-based
Vanguard Group Inc.; San Francisco-based Charles Schwab Corp.;
Bank of New York Mellon Corp.; New York’s BlackRock Inc.;
Goldman Sachs Group Inc. in New York; San Francisco-based Wells
Fargo & Co. and Morgan Stanley in New York, according to
research firm Crane Data LLC.

“The proposed ideas don’t adequately consider the
unintended consequences on retail investors, or on the capital
markets and municipalities that finance themselves through the
money markets, and so we will continue to advocate for this
important investment tool,” Marie Chandoha, president of
Charles Schwab Investment Management, said in an e-mailed
statement.

Bobbie Collins, a spokeswoman at BlackRock, Patrice
Kozlowski of BNY Mellon, John Roehm of Wells Fargo, Adam Banker
of Fidelity and Ianthe Zabel of the ICI declined to comment.
Officials for JPMorgan, Federated and Vanguard didn’t return e-mails seeking comment.